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Regulation Crowdfunding - Definition

February 24, 2022

California

,

United States of America

Issue

What is the definition of 'crowdfunding' under the Jumpstart our Business Startups Act?

Conclusion

Title III of the Jumpstart Our Business Startups Act ("JOBS Act") exempted crowdfunding from certain requirements of the Securities Act of 1933. "Crowdfunding" is not explicitly defined in the JOBS Act.

However, 15 USCS § 77d(a)(6), which was added by section 302(a) of Title III of the JOBS Act, describes the types of transactions that the crowdfunding exemption applies to. Under the crowdfunding exemption, the restrictions of 15 U.S.C. § 77e do not apply to transactions involving the offer or sale of securities by an issuer provided that: (a) the aggregate amount sold to all investors by the issuer during the 12-month period preceding the date of such transaction is not more than $1,000,000; (b) the aggregate amount sold to any investor by an issuer during the 12-month period preceding the date of such transaction does not exceed certain thresholds; (c) the transaction is conducted through a broker or funding portal that complies with the requirements of section 4A(a); and, (d) the issuer complies with the requirements of section 4A(b).

In the SEC's final rule, "Regulation Crowdfunding," the SEC described "crowdfunding" as a relatively new and evolving method of using the Internet to raise capital to support a wide range of ideas and ventures. An entity or individual raising funds through crowdfunding typically seeks small individual contributions from a large number of people. Individuals interested in the crowdfunding campaign – members of the “crowd” – may share information about the project, cause, idea or business with each other and use the information to decide whether to fund the campaign based on the collective “wisdom of the crowd.”

The final rules promulgated in Regulation Crowdfunding were subsequently codified at 17 CFR 227, which is entitled "Regulation Crowdfunding, General Rules and Regulations." This part does not provide a definition of the term "crowdfunding." (Regulation Crowdfunding, 17 CFR 227.100)

No caselaw or other statutes were identified that define "crowdfunding" for the purposes of the JOBS Act.

Law

Title III of the Jumpstart Our Business Startups Act ("JOBS Act") exempted crowdfunding from certain requirements of the Securities Act of 1933 (the "Securities Act"). "Crowdfunding" is not explicitly defined in the JOBS Act.

However, 15 USCS § 77d(a)(6), which was added by section 302(a) of Title III of the JOBS Act, describes the new types of transactions to which the restrictions of 15 U.S.C. §77e do not apply:

(a) In general

The provisions of section 77e of this title shall not apply to-

[...]

(6) transactions involving the offer or sale of securities by an issuer (including all entities controlled by or under common control with the issuer), provided that—

(A) the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, is not more than $1,000,000;

(B) the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, does not exceed—

(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and

(ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000;

(C) the transaction is conducted through a broker or funding portal that complies with the requirements of section 4A(a) [15 USCS § 77d-1(a)]; and

(D) the issuer complies with the requirements of section 4A(b) [15 USCS § 77d-1(b)].

On October 30, 2015, the Securities and Exchange Commission published the final rule Regulation Crowdfunding, Securities Act Release No. 33-9974, Exchange Act Release No. 34-76324 (Oct. 30, 2015), 80 FR 71388 (Nov. 16, 2015) ("Regulation Crowdfunding") to implement the requirements of Title III of the JOBS Act. The SEC described what crowdfunding is in the introduction (at 6):

Crowdfunding is a relatively new and evolving method of using the Internet to raise capital to support a wide range of ideas and ventures. An entity or individual raising funds through crowdfunding typically seeks small individual contributions from a large number of people. Individuals interested in the crowdfunding campaign – members of the “crowd” – may share information about the project, cause, idea or business with each other and use the information to decide whether to fund the campaign based on the collective “wisdom of the crowd.” The Jumpstart Our Business Startups Act (the “JOBS Act”),1 enacted on April 5, 2012, establishes a regulatory structure for startups and small businesses to raise capital through securities offerings using the Internet through crowdfunding. The crowdfunding provisions of the JOBS Act were intended to help provide startups and small businesses with capital by making relatively low dollar offerings of securities, featuring relatively low dollar investments by the “crowd,” less costly. Congress included a number of provisions intended to protect investors who engage in these transactions, including investment limits, required disclosures by issuers, and a requirement to use regulated intermediaries. The provisions also permit Internet-based platforms to facilitate the offer and sale of securities in crowdfunding transactions without having to register with the Commission as brokers.

Regulation Crowdfunding permits individuals to invest in securities-based crowdfunding transactions subject to certain thresholds, limits the amount of money an issuer can raise under the crowdfunding exemption, requires issuers to disclose certain information about their offers, and creates a regulatory framework for the intermediaries that facilitate the crowdfunding transactions. Certain companies are not eligible to use the Regulation Crowdfunding exemption, including non-U.S. companies, companies that already are Exchange Act reporting companies, certain investment companies, companies that are disqualified under Regulation Crowdfunding’s disqualification rules, companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies. Securities purchased in a crowdfunding transaction generally cannot be resold for a period of one year (at 10-12):

Regulation Crowdfunding, among other things, permits individuals to invest in securities based crowdfunding transactions subject to certain thresholds, limits the amount of money an issuer can raise under the crowdfunding exemption, requires issuers to disclose certain information about their offers, and creates a regulatory framework for the intermediaries that facilitate the crowdfunding transactions. As an overview, under the final rules:

- An issuer is permitted to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period;

- Individual investors, over the course of a 12-month period, are permitted to invest in the aggregate across all crowdfunding offerings up to: o If either their annual income or net worth is less than $100,000, then the greater of:

$2,000 or

5 percent of the lesser of their annual income or net worth.

- If both their annual income and net worth are equal to or more than $100,000, then 10 percent of the lesser of their annual income or net worth; and

- During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.

Certain companies are not eligible to use the Regulation Crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are Exchange Act reporting companies, certain investment companies, companies that are disqualified under Regulation Crowdfunding’s disqualification rules, companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Securities purchased in a crowdfunding transaction generally cannot be resold for a period of one year. Holders of these securities do not count toward the threshold that requires an issuer to register its securities with the Commission under Section 12(g) of the Exchange Act if the issuer is current in its annual reporting obligation, retains the services of a registered transfer agent and has less than $25 million in assets.

The final rules promulgated in Regulation Crowdfunding were subsequently codified at 17 CFR 227, which is entitled Regulation Crowdfunding, General Rules and Regulations. This part does not provide a definition of the term "crowdfunding." 17 CFR 227.100 sets out the crowdfunding exemption and requirements available to an issuer who offers or sells securities in reliance on section 4(a)(6) of the Securities Act (15 USCS § 77d(a)(6)):

(a) Exemption. An issuer may offer or sell securities in reliance on section 4(a)(6) of the Securities Act of 1933 (the "Securities Act") (15 U.S.C. 77d(a)(6)), provided that:

(1) The aggregate amount of securities sold to all investors by the issuer in reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) during the 12-month period preceding the date of such offer or sale, including the securities offered in such transaction, shall not exceed $1,070,000;

(2) The aggregate amount of securities sold to any investor across all issuers in reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) during the 12-month period preceding the date of such transaction, including the securities sold to such investor in such transaction, shall not exceed:

(i) The greater of $2,200 or 5 percent of the lesser of the investor's annual income or net worth if either the investor's annual income or net worth is less than $107,000; or

(ii) 10 percent of the lesser of the investor's annual income or net worth, not to exceed an amount sold of $107,000, if both the investor's annual income and net worth are equal to or more than $107,000;

Instruction 1 to paragraph (a)(2). To determine the investment limit for a natural person, the person's annual income and net worth shall be calculated as those values are calculated for purposes of determining accredited investor status in accordance with § 230.501 of this chapter.

Instruction 2 to paragraph (a)(2). A person's annual income and net worth may be calculated jointly with that person's spouse; however, when such a joint calculation is used, the aggregate investment of the investor spouses may not exceed the limit that would apply to an individual investor at that income or net worth level.

Instruction 3 to paragraph (a)(2). An issuer offering and selling securities in reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) may rely on the efforts of an intermediary required by § 227.303(b) to ensure that the aggregate amount of securities purchased by an investor in offerings pursuant to section 4(a)(6) of the Securities Act will not cause the investor to exceed the limit set forth in section 4(a)(6) of the Securities Act and § 227.100(a)(2), provided that the issuer does not know that the investor has exceeded the investor limits or would exceed the investor limits as a result of purchasing securities in the issuer's offering.

(3) The transaction is conducted through an intermediary that complies with the requirements in section 4A(a) of the Securities Act (15 U.S.C. 77d-1(a)) and the related requirements in this part, and the transaction is conducted exclusively through the intermediary's platform; and

Instruction to paragraph (a)(3). An issuer shall not conduct an offering or concurrent offerings in reliance on section 4(a)(6) of the Securities Act of 1933 (15 U.S.C. 77d(a)(6)) using more than one intermediary.

(4) The issuer complies with the requirements in section 4A(b) of the Securities Act (15 U.S.C. 77d-1(b)) and the related requirements in this part; provided, however, that the failure to comply with §§ 227.202, 227.203(a)(3) and 227.203(b) shall not prevent an issuer from relying on the exemption provided by section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)).

(b) Applicability. The crowdfunding exemption shall not apply to transactions involving the offer or sale of securities by any issuer that:

(1) Is not organized under, and subject to, the laws of a State or territory of the United States or the District of Columbia;

(2) Is subject to the requirement to file reports pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") (15 U.S.C. 78m or 78o(d));

(3) Is an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), or is excluded from the definition of investment company by section 3(b) or section 3(c) of that Act (15 U.S.C. 80a-3(b) or 80a-3(c));

(4) Is not eligible to offer or sell securities in reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) as a result of a disqualification as specified in § 227.503(a);

(5) Has sold securities in reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) and has not filed with the Commission and provided to investors, to the extent required, the ongoing annual reports required by this part during the two years immediately preceding the filing of the required offering statement; or

Instruction to paragraph (b)(5). An issuer delinquent in its ongoing reports can again rely on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) once it has filed with the Commission and provided to investors both of the annual reports required during the two years immediately preceding the filing of the required offering statement.

(6) Has no specific business plan or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.

(7) [Effective 1/14/2021through 3/1/2023.] Seeks to rely on § 227.201(aa) to conduct an offering on an expedited basis due to circumstances relating to coronavirus disease 2019 (COVID-19), where such offering is initiated between May 4, 2020, and February 28, 2021, or seeks to rely on § 227.201(bb), where such offering is initiated between March 1, 2021, and August 28, 2022, and:

(i) Was organized and had operations less than six months prior to the commencement of the offering; or

(ii) Sold securities in reliance on section 4(a)(6) of the Securities Act and has not complied with the requirements in section 4A(b) of the Securities Act (15 U.S.C. 77d-1(b)) and the related requirements in this part.

(c) Issuer. For purposes of § 227.201(r), calculating aggregate amounts offered and sold in § 227.100(a) and § 227.201(t), and determining whether an issuer has previously sold securities in § 227.201(t)(3), issuer includes all entities controlled by or under common control with the issuer and any predecessors of the issuer.

Instruction to paragraph (c). The term control means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the entity, whether through the ownership of voting securities, by contract or otherwise.

(d) Investor. For purposes of this part, investor means any investor or any potential investor, as the context requires.

No caselaw or other statutes were identified that define "crowdfunding" for the purposes of the JOBS Act.

Sec. & Exch. Comm'n v. Inteligentry, Ltd., 2:13-cv-00344-RFB-NJK (D. Nev. 2015) ("Inteligentry") was decided before the SEC published Regulation Crowdfunding. In Inteligentry, the United States District Court for the District of Nevada explained that the defendant did not establish how the JOBS Act might exempt the corporate defendants from SEC registration requirements. The Court noted that the most likely provision that might exempt the defendants, the crowdfunding exemption under Title III of the JOBS Act, had not yet been implemented by the SEC and thus was not a valid exemption at the time this case was decided (at 20):

The Jumpstart our Business Startups Act ("JOBS Act") was signed into law in April 2013. PL 112-106, April 5, 2012, 126 Stat 306; see generally 50A N.J. Prac., Business Law Deskbook § 30:3 (overviewing the JOBS act). This date is well after much (though not all) of the alleged unlawful securities transactions in this case. See Compl. ¶ 1, ECF No. 1. More importantly, Rohner has not established, and the Court does not see, how the JOBS Act might exempt Rohner or the Corporate Defendants. The most likely provision—the crowdfunding exemption under Title III of the JOBS Act—has yet to be implemented by the SEC and therefore is not yet a valid exemption. Moreover, once rules are adopted, the crowdfunding exemption requires offerings to be transacted through a compliant broker or funding portal, something that has not happened here. The Court finds no exemption applies.

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